It’s another Jess Irvine piece. You won’t get it because Jess didn’t get it. She writes with all the aplomb of someone who has read about what Paul Keating said to John Laws back in the winter of 1986, but has never thought about it all that much – she sure as hell doesn’t remember it the way many people will. You come away from this 1000 words of shinola with the idea that Jess has never known debt and its impact on the national economy going bad, and probably has never been in a situation where she (or her family) owes a lot of money and is concerned about whether they will have a job in six months. If this is what Fairfax is now stooping to serving up, then I hope she doesn’t have a large mortgage – for the end may come quick.
A trillion dollars in debt, but no ‘banana republic’
On May 14 1986, treasurer Paul Keating delivered his famous warning that Australia risked becoming a “banana republic”.
The comment was a reaction to figures showing the biggest current account deficit ever recorded, at 6 per cent of GDP.
Low commodity prices, high government debts and high interest rates were, indeed, crippling the economy.
This far, at least, Jess and I are like peas in a pod. It was that day in 1986, the comments were a reaction to the current account, and low commodity prices, higher interest rates, and government debt were the backdrop factors.
I remember the time well, because at that time I was at university doing economics, and recall vividly the lengthy discussions we had at that time about Australia’s economic predicament, and particularly a regular theme that Australia had regularly (late 60s, and then again in 1981-82) completely cocked up managing resources booms in such a way as to imperil the financial system (late 60s and the nickel boom) the underlying budget structure and ultimately Australia’s competitive position (early 80s). Keating, as treasurer, having observed that Australia had the world’s best industrial museum, was keen to do something about the competitive position of Australian labour.
From there the key take aways are the points about:-
Commodity prices (they remained in the ditch for a generation until going ape on the back of a China boom from where they are returning to the ditch –and are only maybe less than half way back there). Here is the RBA Commodity prices index, with this annotated below.
High government debts (are no longer ‘the’ issue but have returned to a level where they are ‘an’ issue, and as Dave Llewellyn Smith regularly points out the next global shock will see an Australian government desperately in need of spending in order to keep up aggregate demand and prevent a load of heavily indebted people (which we will come to) from coughing up their loans and offloading assets in such a way as to create a disorderly adjustment of asset prices – which we could think of as a ‘fire sale’.
Now a casual glimpse at this chart may have the undiscerning viewer unconcerned. We can see that although government debt has risen in the last 8 or 9 years we can see it has risen from a point where the Government had no net debt at all (2007-8-9). It becomes a tad more concerning when we see the below (from a previous budget, annotated by moi).
As the RBA has noted it is on something of an upward trajectory
And if the raw dollars will be of interest here they are.
When Paul Keating was warning about bananas in 1986 net government debt to GDP was less than it is now. But this isnt a major concern as yet because of the other factor Jess pointed to.
Interest rates (have dropped a long way since the 1980s and remained pretty much nailed to the floor in recent years as various global central banks printed money, quantitatively eased and even experimented with negative rates)
That falling interest rate has seen households load up on debt like its going out of fashion.
In relation to our GDP it has grown significantly, and as can be seen from the below charts, Australia is world leading, Australian households have led Australia in taking on debt, and they are now geared to a point north of their eyeballs.
Meanwhile back with Jess
But Keating was impatient to get moving on his program of reforms to liberalise the economy, including privatisations and wage decentralisation. The dollar had already been floated.
Appearing on the John Laws program that day, Keating extemporised that: “I get the very clear feeling that we must let Australians know truthfully, honestly, earnestly, just what sort of international hole Australia is in.
“If this government cannot get the adjustment, get manufacturing going again, and keep moderate wage outcomes and a sensible economic policy, then Australia is basically done for. We will just end up being a third-rate economy, a banana republic,” he warned.
You could buy most of that but note that by 1986 Keating had in fact already implemented a lot of his reforms. The privatisations and the wage decentralisation were certainly to come in the ensuing years, as were a number of financial system reforms, but the key tenets of the Keating era – of more exposure to global competition and better positioning of Australian labour and capital to meet that competition had already largely been established.
Jess tacks on at the end one of the all time great pieces of bullshit.
If Jess had familiarity with just one quote by the man then she would know better to suggest he wasn’t really concerned about the current account. This was what he actually said to John Laws on that day:-
‘We took the view in the 1970s – it’s the old cargo cult mentality of Australia that she’ll be right. This is the lucky country, we can dig up another mound of rock and someone will buy it from us, or we can sell a bit of wheat and bit of wool and we will just sort of muddle through … In the 1970s … we became a third world economy selling raw materials and food and we let the sophisticated industrial side fall apart … If in the final analysis Australia is so undisciplined, so disinterested in its salvation and its economic well being, that it doesn’t deal with these fundamental problems … … Then you are gone. You are a banana republic.’
From there you could also note that even when he was out of politics he was still taking swipes at peter Costello about how the Liberal growth was all about blowing out the current account.
‘Between 1999 and 2004 there was no investment in Australia, it all went into housing and consumption all borrowed on the current account. When Peter Costello runs around saying, ‘Oh we’ve paid off the debt,’ it’s like the pea and thimble trick. The Government debt or the massive private debt abroad? It’s continuing to grow.’
Yet here is Jess suggesting he was using the current account to lever the possibility of other reforms. From there she moves off into a land where economists aren’t worried about current accounts.
Absolutely nothing to clothe that statement whatsoever. Just a bland statement of palsied illogicality devoid of any sort of caveat or explanation of any kind. Maybe its an immutable law of Jess Irvine economics. Maybe creditors don’t worry about debtors where they are nations. Try running that line in Russia or Argentina, or South Africa, or even New Zealand. Maybe economists don’t worry about it, though I know plenty who do, but Westpac CEO Brian Hartzer certainly outlined the key dynamic for us just last week.
‘”This country has a current account deficit – that means we borrow overseas to fund the Australian economy.’
Just for the record the Irvine piece has a chart in it which lays it all out pretty clearly. A chart showing Australia hasn’t really had a sniff of an annual current account surplus in a long time.
Another chart from the Rupertarian earlier this year is even starker. In only 13 years since federation has Australia ran an annual current account surplus.
What is Jess suggesting? That all that principle and all that interest doesn’t count? That we just go and borrow some more whenever we have a need?
What Irvine doesn’t seem to get is that Australians gorging on debt on a raft of endless national current account deficits has only been possible up until the 1970s in a much smaller protected economy sustained by the idea it was creating a modern industrial economy, and since the early 1980s by an era of ever easier interest rate cycles globally. But that era is now looking at being pared back, as the Fed, Bank of China, ECB and BoJ (inter alia) look at winding down the supports they brought in for the post GFC era to prevent demand collapse. Sure I dont think anyone will be raising rates with gusto any time soon, but the prospect of serious cuts by anyone must be receding too. A recent Bloomberg chart suggest globally interest rates are looking upwards, and that Australia is the outlier. Given that Australia needs to fund all that debt then higher rates offshore are going to be felt at home.
As long as government debt is under control, most economists are happy to see our persistent deficits with the world as the decision of “consenting adults” from the private sector, who simply see more opportunities for investment in Australia than can be funded by domestic savings.
Indeed, since the First Fleet arrived on Sydney shores, Australia has tended to run current account deficits, requiring a steady inflow of capital to fund them.
In the three decades since Keating delivered his warning, our current account deficit has cycled between 2 and 6 per cent of GDP – even going as high as 7 per cent as the investment phase of the mining boom ramped up in the mid 2000s.
But something odd has happened in the past year that hasn’t happened since before Keating floated the dollar.
Lets break this down too.
Maybe Jess missed the GFC where lots of consenting adults in places like the United States, Spain, Greece, and lots of banks across the developed world found that a lot of those consenting adults decisions had issues which meant that creditors weren’t likely to get their money back. And the suggestion that the consenting adults in Australia ‘simply see more opportunities for investment in Australia than can be funded by domestic savings’ is nothing short of laughable. She should do some court reporting and see if any crime syndicates suggest their lower level underlings steal and deal drugs because they ‘see more opportunities than can be funded by their savings,’ or if maybe some of them see no alternative.
For, as we all know, the only thing done in Australia with debt is speculation in housing , mostly in mortgages, and in recent years increasingly to investors (or speculators). Australia has created a real estate borrowers and speculators paradise like no other on the planet. This chart from Callam Pickering this week, shows us nicely.
Australian banks do little else.
…..those ‘investment opportunities which can’t be funded from within Australia’ are mainly Australian houses (and apartments, and if you dig deeper it is mainly just the land they are built on). They aren’t anything productive, because as anyone who reads MacroBusiness regularly knows houses are mainly a social good, which becomes a cost for anyone doing anything which remotely involves exposure to the rest of the world. Australia takes a somewhat painful economic point, and turns it into a downright piece of economics BDSM by allowing Australian banks to borrow offshore, increasing demand for Australian dollars and nailing the currency higher than it would otherwise be. This makes Australian houses central to a pincers crushing Australia’s competitive position. On the one hand the banks lend more and more against housing and driving workers further into debt to get a roof over their heads, making them more desperate for wage increases, and increasing the real estate costs associated with doing any business at all, but on the other the extra volumes borrowed from offshore and sprayed into the housing sector are the vehicle by which Australia’s currency is prevented from adjusting to the wider economy’s palsied competitive position by falling.
The only way that could make any sense is if Australia were to never face any form of competitive pressure from offshore ever again, and commodity prices were to remain at elevated levels (and the government taxing the people digging them out of the ground etc), and that is before we even start to think about borrowing money from offshore to lend to foreigners speculating in Australian housing, or running the population ponzi to overload infrastructure (which presumably wouldn’t ever be needed if all we were ever going to do was dig our existing resources out of the ground and share the proceeds amongst ourselves).
Certainly Australia ran current account deficits from the first fleet to the late 1980s under the guise of nation building and competition. It has run them since the late 1990s on the basis we should be relaxed and comfortable, against a backdrop of easing interest rates globally which have made our debt servicing reasonably OK. And our debt servicing is still OK. But should interest rates rise or should we be relying on something other than mining to earn our crust then we are likely to find it becomes more painful to carry.
It’s time we finally stopped worrying, and learned to love the foreign debt.
Call it the mysterious case of the incredible shrinking current account deficit, which today sits at less than 1 per cent of GDP.
Indeed, if we were to keep going at this pace, Australia may yet become a nation of current account surpluses – whereby we save more than we invest.
The Reserve Bank is on the case, with a recent speech by deputy governor, Guy Debelle, and an article released this month by three Reserve Bank economists, Susan Black, Blair Chapman and Callan Windsor, seeking to explain the recent trends.
From here Jess extrapolates the current account surplus we still haven’t had, but have got closer to in the last couple of quarters may turn into an endless waltz of them. The below RBA chart should help, particularly if one thinks that the only thing Australia does to earn income from offshore is sell stuff in the ground or grown on top of it, and reconciles that with the possibility of a downturn in mining commodity prices. Strangely enough, in all my readings of RBA literature I haven’t seen any iota of them considering this is a risk Australia faces.
For anyone wondering, the RBA June 2017 Bulletin ‘Australian Capital Flows‘ by Black, Chapman & Windsor at no point refers to any likelihood of ‘Australia may yet become a nation of current account surpluses – whereby we save more than we invest.’ If Jess read the bulletin (which I doubt she did other than to note there was one) and thought that then she probably needs to do a little work on comprehension. A Guy Debelle speech in Sydney on April 6, 2017 on exactly the same subject also made no reference to Australia becoming a nation of current account surpluses, and a cursory glance though all of Debelle’s speeches since then leads only to the conclusion that psychotropics abuse is now possibly a factor in what Jess writes.
Meanwhile back at th ranch, Jess is still confused.
Of course, the obvious reason for the shrinking deficit with the rest of the world is the fact that Australia’s commodity export volumes are finally kicking in.
Indeed, we have racked up several recent surpluses on the trade balance part of the current account – what we earn for our exports minus what we spend on imports.
More curious has been the movements in the other component of our current account balance – the “net income balance”.
That’s the balance of all outgoing payments to foreigners as dividends and interest payments and all incoming receipts from Australian-owned foreign assets which bring dividends and interest payments back into the country.
This second component of the current account balance has always traditionally been in deficit, but has narrowed markedly this decade.
According to Debelle and co, the period between 2010 and 2013 saw a sharp decline in interest payments made by Australians to foreigners. This was due to lower interest rates plus a shift towards government borrowings making up a higher share of total debts. Governments are perceived as more creditworthy than private sector borrowers, meaning they pay lower interest rates on their borrowing.
At the same time, lower commodity prices were slicing mining company profits, and thus dividend payments to the foreign owners of those companies.
From 2013 to 2016, there was another distinct period in which the net income deficit shrank – attributable largely to another Keating invention – compulsory superannuation.
Thanks to the reforms to super introduced by Keating 25 years ago today, July 1, Australians have for several decades had 9 per cent of their salary tipped into superannuation accounts.
The idea that maybe she simply doesn’t get what she is writing about screams loudly from the page as one reads through Debelle’s speech on April 6 in Sydney. If this is what Australian journalism has come to then maybe it is time for Fairfax to simply put up the shutters and be done with it. Below is the key part of Debelle’s speech with regard to what Irvine is on about (the Current Account Balance chart above is the one he refers to).
‘Over recent years, one of the more interesting trends has been the decline in the net income deficit. The net income deficit reflects the returns on foreign holdings of Australian assets compared with Australian holdings of foreign assets, be it in the form of interest, dividends or reinvested earnings. Australia has had a net income deficit since at least 1960 – a direct consequence of the net foreign liability position.
Since late 2010, Australia’s net income deficit, as a per cent of GDP, has narrowed to be around its lowest level since the Australian dollar was floated (Graph 5). This has been associated with a narrowing of the current account deficit to its lowest share of GDP since the early 1980s. There are two distinct periods with different drivers behind this.
The narrowing in the net income deficit from late 2010 to late 2013 mostly reflected a decline in income payments on Australians’ foreign debt and equity liabilities. The lower average yield paid on Australian foreign debt was due to a combination of declines in Australian interest rates and an increase in the share of Australia’s foreign debt attributable to the Australian Government, which pays a lower rate of interest than private sector borrowers. The decline in the payments on equity liabilities was a result of lower profitability of the mining sector. Because Australia’s mining sector is majority foreign owned, a reduction in the profitability of that sector gives rise to smaller payments to the foreign owners, either in the form of dividend payments or reinvested earnings, thereby reducing the net income deficit.
Since 2013, the reduction in the net income deficit has instead reflected an increase in returns on Australian residents’ offshore equity holdings. These increased returns are directly related to the determinants of the shift towards a net equity asset position that I just touched on: namely, continued flows into offshore equity by Australian superannuation funds and the depreciation of the exchange rate, which increases the Australian dollar value of dividend receipts.
In the most recent national accounts, profits of private corporations rose by more than 15 per cent – the second largest increase in the history of the accounts – driven by a huge rise in profitability in the mining sector, in turn a reflection of the recent sharp rise in the prices of coal and iron ore. Based on company announcements, some of these profits are likely to be distributed to foreign owners as dividends. Moreover, to the extent that mining sector profits remain high over the next quarter or so, we could expect to see income outflows as these profits are distributed to foreign owners, all other things being equal. This is likely to increase the net income deficit in coming quarters, but not contribute to gross capital inflows to the mining sector, in contrast to previous periods of high profitability, when profits were reinvested to fund increased investment spending.’
Guy Debelle, Sydney April 6, 2017
Of course Jess then regurgitates that in another guise, in a manner befitting of a university student who knows they should paraphrase someone important in an essay due the day before it is being written, but shouldn’t be caught plagiarising.
An increasing share of that money has been invested offshore into foreign shares and assets, bringing dividend and other receipts coming home to balance all those going offshore.
Remarkably, Australians now own as much foreign equity as foreigners own of Australian equity – that’s new and explained almost entirely by super.
Also between 2013 and 2016, the Australian dollar fell, increasing the dollar value of all those incoming dividend receipts.
The net effect was another large shrinking in the net income deficit – a major reason behind the falling current account deficit during that time.
Since 2016 and into 2017, a sharp rise in the profitability of mining companies – off the back of resurgent commodity prices – has meant higher dividend payments going back to the foreign owners of those companies, widening the net income deficit again.
Complete discombobulation unfolds in the final stanza which is almost cringeworthy to read, so palpable is the incomprehension
In truth, those current account surpluses may prove more elusive than at first blush.
And that may be no bad thing.
To the extent that our stock of foreign debt – now at more than $1 trillion – is used to fund national investment, which increases the economy’s productive capacity, and our ability to repay that debt in the future, it is a good thing.
Indeed, after a period of below-par growth, what the Australian economy needs most right now is a period of higher private sector investment, and that means running a higher current account deficit than otherwise.
It’s time we finally stopped worrying, and learned to love the foreign debt.
Ross Gittins is on leave.
Well at least we get some semblance of an idea that she recognises that endless current account surpluses probably aren’t on the menu. But is this good or is this bad? We wouldn’t want to be paying our way with a Current Account Surplus now, would we? Or would we?
Is it better to use offshore debt to pay for investment in productive capacity? Or should we use that for non productive investment in real estate speculation while nailing our competitive position to the roof with the currency? From there we farnarkle across to an exhortation for more private sector investment (in houses or something which is productive? And should it be productive at the national economic level over the longer term, or productive at the individual level at the point at which they offload the asset? ) which of course, means we simply must have a higher current account deficit.
And the really sad thing is that the final line probably comes from another Debelle speech (and not from familiarity with one of the greatest black comedy films of all time. I suspect she picked it up from How I Learned to Stop Worrying and Love the Basis – Basel (Guy Debelle, 22 May 2017) while looking through his recent speeches.